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Adjustable Rate Mortgage (ARM) has a fixed adjustment period that is explained in the mortgage note. Many lenders attach an ARM addendum to the mortgage note clarifying unique ARM terms.
ARM loans amortize (payoff) in the same manner as a fixed rate loan.
An addendum to the "Deed of Trust" or "Mortgage" describing the ARM terms will be recorded at time of loan closing.
All ARMs have a set time period before adjustment. ARM adjustment periods vary with the selected ARM program. The only difference between a Fixed and ARM loan is that the ARM rate changes periodically over the life of the loan.
ARMs can adjust every 1, 3, 6, 12, 18, 24, 36, 60, 84 or 120 months.
Sub-Prime lenders will fix the interest rate for eighteen (18), twenty four (24) or thirty six (36) months and then convert to a 6 or 12 month ARM.
Many lenders are offering hybrid ARMs that have a fixed rate period for 3, 5, 7 or 10 years before converting to a 6 or 12 month ARM.
All ARMS, except the POARM, have adjustment caps. Traditional semi-annual ARMs have a of plus or minus 1.0% adjustment cap, whereas the 12 month ARM will have a plus or minus 2.0% adjustment cap.
Adjustment caps can vary with selected ARM loan program. The lender ARM disclosure notice will outline the ARM program.
Sub-Prime ARM lenders use 1.5% semi-annual caps and a 3.0% annual cap.
The ARM "Fully Indexed Rate" (FIR) formula computes the indicated ARM interest rate at time of adjustment. The interest rate adjustment cap will limit the increase or decrease of the existing interest rate to the cap percentage.
As an example, the current semi-annual interest rate is 6.0%. At the end of the 6 month fixed period, the maximum rate increase or decrease is limited to 1.0%. The interest rate for the next 6 months can not be less than 5.0% or greater than 7.0%.
If the FIR is somewhere in between the 5 and 7% limit, then the FIR sets the interest rate for the next 6 months: FIR = 6.125% and is between the 5.0% and 7.0% limits, therefore the rate is 6.125% for next 6 months.
If the FIR = 7.5%, then the maximum rate for the next 6 months is 7.0%.
ARM loans will have a life cap of 5 or 6 percent above the initial start rate i.e. initial rate is 5.500%, then the life cap would be either 10.5 or 11.5%.
Each lender will have their own desired life cap based on capital market investment requirements and inflation expectations.
Volatile markets create specific demands.
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